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Peabody Energy Remains the Safest Bet on a Coal Revival

By Vladimir Zernov – Jul 24, 2014 at 9:52AM

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Solid cost performance and good liquidity mean Peabody Energy is well positioned to profit from coal price improvements when they finally occur.

Peabody Energy's (BTU) second-quarter earnings report confirmed the company's stance as one of the most stable coal miners. The company's adjusted loss of $0.28 per share was in line with expectations, and it managed to grow its revenue by 2% despite significant headwinds. While difficult times are far from over for coal miners, Peabody confirmed once again that its position is solid.

Recent developments signal Australian segment results will improve
Earlier this month, Australia decided to repeal its carbon emission tax. This tax raised electricity bills for consumers and lifted costs for producing coal. This move will greatly benefit producers with a large presence in Australia, like BHP Billiton (BHP -0.95%) and Rio Tinto (RIO -0.72%). Peabody Energy's Australian operations are set to benefit as well.

The company's Australian segment continues to be pressured by low seaborne coal pricing. However, internal developments are encouraging. Operating costs in Australian operations dropped from $74.26 per ton in the first quarter to $72.30 per ton in the second quarter. This improvement helped to sustain a positive gross margin for the segment.

One should not count on fast changes in Peabody's Australian segment profitability. Met-coal pricing remains an issue, and the third-quarter benchmark settled at $120 per ton, which is not good news for pure met-coal plays like Walter Energy (WLTGQ). At least it didn't get worse this time.

While met-coal prices struggle to rebound, Peabody Energy continues to count on production cuts from competitors. Walter Energy has already idled its entire Canadian operations this year. The latest move on this front came from Arch Coal (NYSE: ACI), which recently announced its decision to idle the Cumberland River complex. Arch Coal stated that it would increasingly shift its portfolio toward lower cost met-coal operations. Possibly, this is a hint that Arch Coal will idle more mines this year.

Such moves are needed for pricing improvements, and that's what producers that keep their production levels hope for. Each piece of news on production cuts from competitors is positive for Peabody Energy, as it brings the time of a rebound in coal prices closer. 

Liquidity remains crucial, and Peabody Energy has it
In current conditions, the only option for coal producers to push costs down is to close higher-cost operations. That's exactly what is going on, although this process could have been faster. After cost-ineffective mines are idled, coal producers will have to wait for a pricing recovery. However, as many coal companies are stuffed with debt, liquidity is a crucial factor.

Peabody is a clear leader on this front. The company finished the second quarter with almost $500 million of cash and $2.1 billion of total liquidity. Reacting to the absence of pricing improvements, Peabody Energy lowered its 2014 capital spending targets to $210 million-$250 million, allocating this money primarily to sustaining capital items.

While competitors like Walter Energy have been hurrying to refinance at unattractive rates, Peabody Energy stood aside from the debt markets this year. Back in 2013, the company replaced a $1.2 billion term loan due in 2015 with a $1.2 billion term loan due in 2020, and this move was sufficient for the near-term needs. The fact that Peabody Energy has no need to refinance right now is a big positive factor, as the debt market is currently inhospitable for coal miners.

Bottom line
Peabody Energy remains the safest bet on a coal revival. Unlike with many other coal miners, there are no doubts about the company's existence. Solid cost performance and good liquidity provide Peabody Energy with time to wait before pricing improves. In my view, pricing improvement on the met-coal front is a question of time, and Peabody Energy has this time. 

Vladimir Zernov has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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